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Jim Rickards

June 17, 2015 interview – please visit the Gold Chronicle website where a full transcript will be posted.

INTEREST RATES

The US Federal Open Market Committee Meeting is held eight times a year and the Fed makes decisions on interest rates.

Late summer of 2014 there was a debate on whether the Fed would raise interest rates at the March 2015 or June 2015 meeting. Jim said at the time that they wouldn’t be able to raise interest rates at all in 2015.

The June 2015 was just held and they didn’t raise rates.

The Fed said their decision depends on the data and the data is lousy.

Yet the Fed keeps talking about raising rates as if the economy was stronger than it is, because they are basing it on forecasting.

Their forecast says the economy will be better so they lead the market to believe they’re going to raise rates.

But the Fed has the worst forecasting record of any major institution. They’re not just off by a little bit, they are wrong every time by orders of magnitude.

The data today is weak and the Fed is engaging in “happy talk”.

Yellen gave the Fed “playbook” at a speech in May 2015. She said they were looking for 2% inflation, 5% unemployment, and 2 1/2% growth before raising rates.

She also said they needed to be ahead of the growth so Jim picked triggers of 1.8% inflation, 5.2% unemployment and 2.2% growth.

When you see two of those three figures trending in the direction Yellen wants then they’re going to raise interest rates – probably within 30 days.

That’s the playbook.

Right now the data is lousy. For example, unemployment is 5.5% moving in the opposite direction from what Yellen wants.

BONDS

Jim spent the last thirty years in the bond market.

When the Federal Reserve wants to increase the money supply they buy bonds with money they create out of thin air.

When they want to decrease the money supply they sell bonds and the money they receive for the bonds goes “poof” into thin air.

The Fed can’t trade alone in making or destroying the money so they have a list of about twenty banks approved to trade with.

Jim spent twenty years as Chief Credit Officer for one of those banks so he’s spent a lot of time in the bond market.

The 80s and 90s were the heyday.

Jim, as a bond dealer, would both buy and sell bonds, the company would use its own capital and there was no problem with quick sales at almost any size — no liquidity problems.

Today that model is gone.

There’s the Basil III capital rule requirements, Volcker Rule and regulatory oversight so the banks have been frightened out of committing their capital.

There is far less liquidity in the bond market now.

Also, today the trading floors with all the shouting are mostly gone. It’s mostly automated, and in that automation there are algorithms with computers trying to front-run each other. As well, there’s dealers who don’t want to commit their own capital.

It’s a perfect storm for things like the bond market flash crash of last October — prices skyrocketed and yields crashed.

We’re going to see more of that.

Before, the dealers would stop the crash because they could see profit, but now the dealers aren’t there and everything rushes to the exit on one side when something tips the boat.

There’s going to be more and bigger flash crashes in the stock market and the bond market.

Be diversified and don’t just trade on fundamentals in stocks and bonds. You’re vulnerable to flash crashes and you need some hard assets.

In the physical gold market the volumes aren’t as big as bonds but the liquidity is very good.

There might come a time where it’s hard to find it to buy but there’s never been a problem with liquidity for those who want to sell gold. Jim recommends just 10% of your investable assets and isn’t considered a gold bug who’s all in.

FLASH CRASHES

Flash crashes have an impact on the whole market.

There’s a “Lehman Effect” where one or more firms go bankrupt as collateral damage. Also, regulators could close markets which feeds the panic.

The panic can lead to large losses but also large gains.

Contagion, or spill over, goes from one market to another and exchanges can be closed in extreme cases.

One month we hear about Russia putting attack viruses in the NASDAQ operating system, which they did, and the next month we hear about the Chinese downloading millions of files from the Federal Office of Personnel Management, which they did.

These are state organized attacks — military cyber brigades.

These aren’t criminals looking for your credit card information.

With the personnel information they could start blackmailing looking for someone who has clearance and is vulnerable to becoming a traitor. They could also see who is working under cover in another country.

There’s cyber warfare going on today.

It doesn’t speak well for economic cooperation.

Donald Trump’s speech announcing his candidacy for President spoke bluntly about trade wars, and putting tariffs on Mexico, China and Russia.

None of these things speak well for the economic environment we’ve had and inexpensive Chinese imports the US has been relying on.

Any financial portfolio that’s all digital and doesn’t have a slice in physical assets is vulnerable to being completely wiped out.

SOUTH CHINA SEA

The conflict in the South China Sea involves a vast amount of oil under the ocean and is also about China emerging as a world power.

Geopolitics is the politics of geography. If you look at a map, the South China Sea is egg shaped and surrounded by six countries.

China is the furthest away.

Vietnam and the Philippines dominate the landscape yet China has claimed the entire thing except a few miles of the other nations’ shorelines.

China is backing up the claim by creating islands out of nothing, populating them with military people and running up a Chinese flag.

They are saying that if someone tries to kick them out then it’s an act of war. We’re just getting closer to a war between the US and China.

The US has treaty obligations with the Philippines.

If the Philippines is attacked then it’s an attack on the US and the US is obligated to come to their aid.

Also, if there’s an accident at sea because of the close proximity then it could spin out of control.

China was a world power before 1840 and now they’re back. They were a highly civilized world power for well over a thousand years and feel like the eclipse was just temporary.

They regard Taiwan as part of China and they got Hong Kong back. They view Korea, Japan and Southeast Asia as their sphere of influence. The US doesn’t see it that way at all.

Jim expects there to be an incident in the South China Sea sooner rather than later.

What’s different now is cyberspace.

There will be more cyber attacks. In the past nations would attack other nation’s economies by bombing, invading or sabotaging.

Today it’s cyberspace.

Looking at finances, if a person has stocks, bonds or money market funds they have digital assets.

If the digital assets could be wiped out in a day in cyber warfare then that’s a reason to own some physical assets.

GOLD CONFISCATION?

Jim believes gold confiscation is highly unlikely.

Not many Americans own gold and there’s been forty years of “radio silence” where no one has talked about it.

Before 1933 you could take a gold coin worth $20 and use it as legal tender to buy dinner.

In 1933 that ended and it became illegal for US citizens to own gold.

The Great Depression started in 1929, unemployment was over 20%, the stock market dropped 85%, and there were currency wars and trade wars all over the world.

A very desperate time.

When President Roosevelt issued the order to confiscate gold people wanted a change and there wasn’t a lot of resistance.

Today would be different. Most of the gold owners prize it highly and don’t trust the US dollar or digital assets, and want some diversity in physical assets — they’re not just casual holders.

There would be a lot more resistance, and a number of prominent politicians would stand up and try to prevent it.

The government may try to go into safety deposit boxes because banks control them so Jim recommends private storage for gold.

The government may put on a tax when you sell it but that’s not a reason not to own gold.

If you see gold go from $1,200 per ounce up to $5,000 per ounce, which Jim expects, then there might come a time where it makes sense to sell it — $4,000, $5,000 or $6,000 per ounce — and then to put the profit into another asset class that’s less likely to be confiscated, like land.

But we’re a long way from that.

As gold goes up it’s really the dollar imploding and gold holding its value.